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About BEFIT, HOTS, and TP

The EU has taken a liking to fiscal regulation: very recently, three fiscal concept directives have been published, which are supposed to be implemented in the coming years. Whether all of this will succeed is still very much in question. However, it is clear that the EU has decided to become heavily involved in the fiscal systems of its member states. Not every member state is equally enthusiastic about this, which could affect the chances of implementation, as unanimity is still necessary for the acceptance of directives. Nevertheless, it is important to stay alert to these proposals because recent experiences have shown that member states are more willing to agree to fiscal directives that aim to combat tax avoidance, which is partly the case with these proposals. In the Caribbean part of the Kingdom of the Netherlands, these rules will not be applicable, but it is still useful to be aware of these developments.

Peter Kavelaars

The first directive is named BEFIT: Business in Europe: Framework for Income Taxation. It's a rather extensive name for a scheme that essentially boils down to a uniform profit base for multinational companies. Such a proposal is not entirely new as a similar proposal was made in the past called the CCCTB directive, which stood for a common consolidated corporate tax base. The CCCTB faced significant resistance and was subsequently simplified into the CCTB, where the "C" for consolidation was dropped. However, this stripped-down variant also faces little support. Now we have BEFIT, which doesn't differ significantly from CCCTB; it again involves a consolidated profit base or an independent fiscal profit determination that applies to all parts of the group, and all profits of the group components are determined collectively. Multinationals are thus no longer subject to local profit taxes. In this regard, there's not much new under the sun. The main difference between BEFIT and CCCTB lies in the allocation of that profit base across member states. Under the CCCTB, this was done through formula apportionment, where profit was allocated to member states based on allocation keys like payroll, assets, and revenue, with taxation occurring at the local rate. In BEFIT, this system has been abandoned, and profit is essentially allocated based on the profits previously earned by the separate parts of the group. In essence, this is the essential difference between BEFIT and CCCTB. In short, it's mostly old wine in new bottles. The main goal of the EU with BEFIT is to eliminate disparities between the fiscal systems of member states and, thereby, reduce tax avoidance opportunities.

The second proposal is HOTS, which stands for the Head Office Tax System. HOTS is intended for small and medium-sized enterprises. In essence, HOTS means that a company operating in more than one EU member state only needs to file for profit tax in the country where its headquarters are located. This filing covers all European group components, albeit limited to permanent establishments. Subsidiaries are not included in the system. Furthermore, HOTS is an optional scheme, so companies are not obliged to participate.

HOTS is primarily aimed at reducing administrative burdens: it requires only one profit calculation and one tax filing. Profit determination is entirely based on the fiscal rules of the country where the headquarters are located, even for establishments in other countries. Profit is calculated per country and then consolidated for the filing. This system not only simplifies the process but, like BEFIT, it removes disparities and reduces opportunities for tax avoidance. Of course, the consolidated profit still needs to be allocated to the member states where the group components are located. This can be done easily by calculating the profit for each part of the company as reported, and these profits are then allocated to the respective member states, where the local tax rate is applied, and tax is due locally. Like BEFIT, HOTS is essentially old wine in new bottles.

Finally, the third proposal is the concept directive on transfer pricing (TP). This is also a notable proposal. After all, the OECD has had the TP Guidelines for many years, which have been more or less accepted and applied worldwide, including in the EU member states. Therefore, it doesn't make much sense to codify them in a directive. The background is that the Guidelines are not an exact science: what constitutes the correct transfer price between affiliated enterprises can be approximated but not precisely defined. The Guidelines offer several methods to determine the correct transfer price. EU member states do not always apply the Guidelines in the same way. The aim of the draft directive is to bring more uniformity to this area. This does not seem very useful to me. Experience shows that the Guidelines usually work well, and the flexibility they offer is beneficial. I suspect that most member states would prefer to keep the EU's interference at bay.

Peter Kavelaars is a professor of Fiscal Economics at Erasmus University Rotterdam and of counsel at Deloitte Dutch Caribbean.


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